With No Vote, Taxpayers Stuck With Tab on Bonds

Surprised local taxpayers from Stockton, Calif., to Scranton, Pa., are finding themselves obligated for parking garages, hockey arenas and other enterprises that can no longer pay their debts.

Officials have signed them up unknowingly to backstop the bonds of independent authorities, the special bodies of government that run projects like toll roads and power plants.

The practice, meant to save governments money, has been gaining popularity without attracting much notice, and is creating problems for a small but growing number of cities.

Data from Thomson Reuters suggests that local taxpayers are backing so-called enterprise debt at five times the rate they did 10 years ago. The resulting municipal bonds are sometimes called “double barreled,” because they are backed by both the future revenue of a project and some sort of taxpayer backstop. The exact wording and mechanics can vary.

With many cities now preoccupied with other crushing costs — pension obligations, retiree health care, accumulated unpaid bills — a sudden call to honor a long-forgotten bond guarantee can be a bolt from the blue, precipitating a crisis. The obligations mostly lurk in the dark. State laws requiring voter pre-approval of bonds don’t generally apply to guarantees. Local governments typically don’t include them in their own financial statements or set aside reserves to honor them.

“These are debts that do not show up clearly, no matter how closely you look at the balance sheets,” said Carmen M. Reinhart, an economist at the Peterson Institute for International Economics who has written extensively about government debt. They “come out of the woodwork in bad times.”

In a number of communities, especially in New Jersey, Michigan and Washington State, local officials have recently scrambled to work out fiscal emergencies caused by guarantees and similar promises. Hoboken dodged a bullet last year, for instance, when a buyer was found for a bankrupt hospital whose debt the city had guaranteed. Buena Vista, Va., narrowly missed a creditor foreclosure of its city hall and police building, after a park authority failed to repay the bonds for a golf course.

In other places, bond guarantees have been time bombs, causing problems too severe to be solved in a workout. Stockton may be headed for Chapter 9 bankruptcy this week after pledging taxpayer money to backstop authorities’ debts for a hockey arena and other showcase buildings. Scranton, a faded former coal center, touched off a full-blown debt crisis this month, losing access to the capital markets when its City Council refused to honor a taxpayer guarantee for a parking authority’s bonds.

Residents of Pennsylvania’s capital, Harrisburg, recently learned from a forensic audit that their city’s fiscal woes could be traced to a guarantee issued in 1998, for the bonds of a trash incinerator project. Every few years after that, the authority running the project issued more bonds, and the city guaranteed those as well.

The audit showed that the authority had been selling new bonds for the cash to pay its older bonds — saving unwitting residents from having to honor their guarantees for a time, but blowing up their debt from the incinerator to an impossible $310 million. That’s more than three times what residents owe on the city’s own bonds.

Harrisburg tried unsuccessfully to declare bankruptcy last year but was blocked by the state. It is widely expected to try again.

Moody’s Investors Service issued a report this year on taxpayer bond guarantees in New Jersey, after noticing a big upswing there since 2008. The firm is making a broad review of places that it rated in the past, where circumstances may now be changed. In New Jersey, it said, some cities and counties had evidently discovered that by working with independent authorities, they could bypass legal limits on their own indebtedness.

The “full faith and taxing power” of communities, a solemn pledge, was being used to guarantee revenue bonds for nonessentials like solar-power projects, apartment buildings and a soccer stadium — things bailout-weary taxpayers might walk away from if the guarantees were called.

Moody’s cut several communities’ own credit ratings to junk, briefly making New Jersey the nation’s leader in junk-rated municipalities. (Now Michigan has that distinction.) The gritty town of Harrison, just across the Passaic River from Newark, had its rating cut a rare eight notches in a single year, when it couldn’t honor a promise to pay debts connected with construction of the Red Bull soccer stadium.

Harrison had to borrow from Hudson County to get through the crisis, but that in turn raised doubts about whether the county’s taxpayers would honor their guarantee of yet another project’s debts — $85 million for a faltering waste-disposal system.

Guess who's on the hook?

“We are seeing more of these than we had seen previously,” said Matt Fabian, managing director of Municipal Market Advisors, a research and advisory firm for municipal bonds. “The weak economy is making weak projects worse. It is undermining cities’ abilities and willingness to backstop these projects when they do fail.”

Though the number of cases is small, Mr. Fabian said, they send a loud signal to investors about a decline in communities’ willingness to honor their promises.

The Governmental Accounting Standards Board on Monday released a draft of a new standard that would require governments to disclose details of the guarantees they have issued for other entities’ debts. The board started working on the new rules last year, after seeing more and more little-known guarantees coming to light.

California's Debt Problem Getting Worse?

CNBC's Jane Wells reports on California's serious budget problems and how Facebook's 30% decline could make the state's debt problem even worse.

The board’s research also showed that some guarantees were very large. The State of Texas, for one, has guaranteed the debts of all the school districts in that state, to the tune of a total of $50 billion. Texas has set aside about $25 billion, however, which analysts consider adequate. A number of states have also guaranteed venture capital projects.

Scranton’s version of a debt crisis began when a local parking authority said it couldn’t make a bond payment coming due in June, calling on the city’s guarantee. The authority had issued bonds to finance parking garages that the city had used in a campaign to woo Hilton Hotels and Resorts to operate a conference center downtown.

Each time the authority issued more bonds, the city backed them with a powerful “full faith and credit” guarantee. But by 2008 the authority had $54 million in bonds outstanding, and was spending about 60 percent of its budget on debt service — so much that it could not cut parking rates to compete with cheaper parking lots nearby.

A majority on the City Council refused to honor the guarantee, saying the authority’s finances were in disarray and they wanted to strike a blow for fiscal rectitude.

Suddenly, Scranton, which has been in dire fiscal straits for years, was a pariah. Only one bank had been willing to help it raise money, and it backed out of a $16 million deal to provide short-term financing. Without that cash, the mayor said Scranton couldn’t make its next payroll. The city’s fuel supplier threatened to halt deliveries of gasoline, which would idle the police cars and garbage trucks. More than a dozen other vendors cut off the city’s credit.

A bond insurer, Radian Asset Assurance, started a 30-day countdown to foreclosure on the authority’s parking garages. The trustee for the bondholders, Bank of New York Mellon, warned that it would get a court-ordered tax increase.

Taken aback, the mayor and City Council changed course, saying Scranton would pay the parking authority’s debts after all. But the damage was done. The initial decision to not make the $1 million bond payment had tainted Scranton’s credit on all of its debts for the foreseeable future.

“There’s no going back,” said Gary Lewis, a Scranton native and accountant who has been trying, so far unsuccessfully, to persuade the City Council to put a public briefing on Chapter 9 bankruptcy onto its agenda. “We’ve proven that the city has failed to comply with its existing bond covenants on absolutely everything we owe.”

Indeed, creditors say they have found other “conditions of default” that cannot be corrected quickly, like the failure to have structural engineers inspect the parking garages, or to get yearly financial audits. Boyd Hughes, a lawyer for the City Council, said he expected creditors to seize the parking garages and sell them to raise cash for the bondholders.

Mr. Lewis, who works on the forced mergers that follow bank failures, said he did not think the garages would fetch enough in a fire sale to cover all the authority’s debts, so the bondholder representatives would soon be back on the city’s own doorstep, clamoring for a tax increase that Scranton’s guarantee legally entitles them to.

“You can’t do it. You can’t raise real estate taxes beyond what they are in this city,” Mr. Lewis said.

Such situations leave states facing painful quandaries, Ms. Reinhart said. In Pennsylvania, not only are Scranton and Harrisburg struggling with bond guarantees, but another troubled city, Allentown, is defending itself against lawsuits by surrounding communities, accusing it of a convoluted plan to make their residents backstop an authority’s bonds for a new hockey arena. Construction has stopped on the arena, and residents are living with a big hole in the ground and a cloud of uncertainty.

“It’s a possibility that Pennsylvania does nothing and says, ‘O.K., you’re on your own. You default, and that’s that,’ ” Ms. Reinhart said. “Or it could be that the state intervenes, even though it doesn’t guarantee the cities’ debt explicitly.” The problem, she said, is that the bailout of just one distressed city “is a license for everybody to overspend, on the assumption that they’ll be bailed out.”